Reaction to Katharina Pistor’s book “The Code of Capital”

I recently read this book and decided that I will include it in the syllabus of my Economic Inequality course. A few days ago, when I indicated on Twitter my intention to write about the book in this blog, I was intending a review. However, I found good reviews online, to which my own review would have little to add. These are: a post in the Law and Political Economy blog by Sam Moyn, and this piece by Rex Nutting on MarketWatch. To these, I can add little of value from the point of view of a legal scholar, such as Sam Moyn, or a commentator on political economy, such as Rex Nutting. Instead, I will quote from the publisher’s online blurb, so you can get a quick idea what the book is about, before proceeding with my comments.

Capital is the defining feature of modern economies, yet most people have no idea where it actually comes from. What is it, exactly, that transforms mere wealth into an asset that automatically creates more wealth? The Code of Capital explains how capital is created behind closed doors in the offices of private attorneys, and why this little-known fact is one of the biggest reasons for the widening wealth gap between the holders of capital and everybody else.

In this revealing book, Katharina Pistor argues that the law selectively “codes” certain assets, endowing them with the capacity to protect and produce private wealth. With the right legal coding, any object, claim, or idea can be turned into capital—and lawyers are the keepers of the code. Pistor describes how they pick and choose among different legal systems and legal devices for the ones that best serve their clients’ needs, and how techniques that were first perfected centuries ago to code landholdings as capital are being used today to code stocks, bonds, ideas, and even expectations—assets that exist only in law.

I am intrigued by this book, in my capacity as an economist, for two main reasons.

  1. The book gives a new and insightful perspective on the nature of capital, not long after Thomas Piketty’s Capital in the Twenty-First Century, a book most certainly discussed in my course on economic inequality. One big criticism of Piketty’s concept of capital, leveled by other economists, is that it diverges from the standard use of “capital” in macroeconomic / growth theory, even though Piketty does appeal to some results from this theory in his analysis. Pistor offers in her book an intriguing definition of capital as the aggregation of a myriad strategies of highly-paid lawyers, who shop around existing legal systems to create encodings of assets into concepts that can be defended as being legal in some court of a recognized state, encodings that serve to make up assets out of “thin air” and make these assets long-lived, accumulating over time, and convertible to money when their owners desire. I am not a macroeconomist, but I am eager to see what my colleagues in that field will come up with by engaging with this definition. After all, Paul Romer’s 2018 Nobel prize was for his incorporation of ideas into growth theory, as boosting the productivity of all other inputs to production (yes, I am simplifying). Intellectual protection legal regimes matter for this for obvious reasons. Pistor essentially says that the ideas of lawyers are part of this process. She explicitly discusses how these lawyerly inventions have expanded the scope of intellectual property protection (simultaneously shrinking the public domain in the realm of ideas), but she says so much more about these lawyerly inventions that there ought to be plenty of material here for some new macroeconomic theory.
  2. The second reason this book intrigues me is that it suggests a diagnosis for the disease of ever-increasing inequality in incomes and wealth levels, with the attendant problems of social polarization, undermining of democratic systems and norms, and empowerment of more and more economic and political oligarchy. It is not the job of a law professor like Pistor to suggest to economists interested in political economy and mechanism design how to think about modeling a way forward to formulate effective social and policy responses to these trends. But she has done all such economists (and I do count myself as part of this group) a favor by her diagnosis. I hope the policy designs and suggestions from economists are not long in coming.

How should we teach introductory economics?

I came across this piece by Dylan Matthews in Vox today. It talks at length about Raj Chetty’s new introductory economics course at Harvard, “Economics 1152: Using Big Data to Solve Economic and Social Problems“. Let me see if I have something useful to add to the discussion of how best to teach economics, especially at the introductory level.

I should start with a disclaimer. I came to economics because of my love of mathematics. I wanted to keep doing mathematics for the rest of my life, but to do it in a field of inquiry that might have social value. On the face of it, this would make you, gentle reader, expect that I would have a negative opinion of a course that eschews abstract theorizing and mathematical tools in teaching economics.

On the contrary, I am all in favor of such an approach, when it’s not the only kind of teaching of economics we do. As I tell all my students who ask seriously about the need for all that mathematics, the economy is massively complicated (nobody has disagreed yet with me on this), and therefore we need to employ the most powerful tools that we can in studying it. These tools can come from mathematics, statistics, political philosophy, history, or anthropology — the more toolbox raids we conduct across the academic disciplines, the better off we are as economists.

I happen to have a small comparative advantage in employing and teaching the tools of mathematics, and so this is mainly what I do in the classroom, although I have been restless and have taught all sorts of different topics, not all with an abstract, math-focused approach. Lately, for example, I have been teaching a new course called Economic Inequality, and indeed Raj Chetty’s work, mentioned by Dylan Matthews in the article linked above, has been taken seriously in this course.

I want to consider a point that Matthews’s article mentions, in my own words and with my own emphasis, I want to mention one more thing about the benefit of mathematical work in developing economic theories, and finally another worthwhile effort at revamping the teaching of introductory economics, one that Matthews does not mention, but one that is well aligned with Chetty’s emphasis in his course.

  1. Data never speaks by itself. We need abstract theorizing and we need serious empirical testing of the theories, and we need this to keep going back and forth. As Chetty says, his course is a good complement to the standard Econ 10 at Harvard, not a substitute. My reason for defending building abstract economic theories is fundamental: if we teach students to jump straight to the data and quasi-natural experiments, that’s all to the good except that then they will be less transparent about the theories that inevitably stand behind what they do with the data. I believe this is a serious issue and burdens everyone doing any kind of science, and it really doesn’t matter if you dislike the approach of Russ Roberts, who is quoted by Matthews as saying basically the same thing. As Matthews says, “Chetty isn’t averse to theory. Much of his work is motivated by a desire to poke at and test widespread theories”, so Chetty is perfectly fine with the coexistence of theory and empirical testing. Hurray for that! My reason for belaboring the point here is that I can see the danger lurking in the minds of students who are annoyed by the difficulty and abstraction of economic theorizing to declare all theory BS and to think that they can understand the economy only with data analysis. I would love for such student skeptics to use the econometric techniques they are learning eagerly to bash economic theories and to help build better theories, theories explicitly stated. I do not want anyone to be a “slave to some defunct economist”, as John Maynard Keynes said, without even realizing it.
  2. Relying only on quasi-experiments to discuss economic news and developments in policy-making is all well and good except when we just don’t have plentiful (or any) data generated in such a way for some topics. Do we then ignore topics like this? Could we not be better off applying theories to make some headway, always being careful to qualify our work by emphasizing the limitations of our theories and the need to test them better? Incidentally, stating our economic theories mathematically forces us to be explicit about their limitations by stating our assumptions. This feature alone, in my mind, justifies the (admittedly large) set-up cost of learning enough mathematics to work with abstract economic theories (so it gets the only bold-faced word in this post).
  3. Finally, Matthews could have cited the fantastic work done by in preparing extensive materials for teaching economics, indeed in a fashion congruent with Chetty’s approach. I understand that this was not the point of his article, but I think that the Core Econ project deserves much wider publicity than it is getting. The more I look at it, the more I feel like arguing for a big change in how my own department teaches principles of economics. I certainly plan to use the Core Econ ebook more in my Economic Inequality course come the Spring, when I teach it again.

The Economics Nobel lectures

When we sat down for breakfast, I opened my iPad on Facebook, as usual at this time of day. I saw a notification from the Nobel Foundation that the Nobel lectures on economics were about to be streamed live. I had forgotten, in the hectic days of winding down the semester, to check for the schedule and I feel extremely lucky I got to watch these lectures by accident.

There was an unfortunate glitch with the audio which forced the stream to be stopped and restarted. As a result, I only got to watch properly the second half or so of the lecture by William Nordhaus, but the streaming of the lecture by Paul Romer went ahead after that without problems.

Both laureates gave great talks, I thought. Of course, I am biased in favor of Romer, as a former student of his. The same ability to explain deep, complicated mathematics that he displayed when I was taking his first-year mathematics-for-economists PhD course in Rochester in 1984 was evident in his engaging Nobel lecture. I particularly liked his one (and only!) slide beyond his cover slide, showing students in Africa reading their textbooks on the side of a highway near the local airport, because there were streetlights there, making it possible to study at night, while their houses had no such luxury

Romer went on to explain in very simple terms the way ideas and their sharing and combinations have made it possible for humans to make progress in material, as well as moral, terms. I was heartened by his talk about how technological progress has expanded the circle of people (and now other sentient beings) that many humans consider US rather than THEM.

Not a small contribution to human progress in both material and moral terms from Paur Romer, an undergraduate physics major who went on to get his PhD and launch his career by doing work that could have easily been considered too arcane, were it not for his commitment to share his ideas in the clearest possible terms for others to use and combine them for yet more ideas to help humans live better.

Long absence from this blog ends now with a post about how experiencing income inequality when growing up affects one’s preferences for income redistribution policies

The Fall semester has proved to be busier than I thought it would be. However, I really do want to come back to this blog, and a paper about inequality I encountered today gave me the push I needed.

The paper is Experienced inequality and preferences for redistribution by Cristopher Roth and Johannes Wohlfart, Journal of Public Economics 167 (2018) 251-262.

The authors use large national datasets to examine the following question: if someone experienced higher inequality when growing up, will they be more or less in favor of redistribution?

Their answer surprised me. Quoting from the abstract of the paper:

people who have experienced higher inequality during their lives are less in favor of redistribution, after controlling for income, demo- graphics, unemployment experiences and current macroeconomic conditions. They are also less likely to support left-wing parties and to consider the prevailing distribution of incomes to be unfair. We provide evidence that these findings do not operate through extrapolation from own circumstances, perceived relative income or trust in the political system, but seem to operate through the respondents’ fairness views.

(Roth and Wohlfart 2018, abstract)

People who grew up experiencing higher inequality demand less redistribution? Of course that is fine if you think of those in the top of the distribution, but the way inequality has developed in a skewed manner in most countries, the majority of the people should be in a less advantageous position and might be expected to have a desire for redistribution policy to reduce the inequality. But they don’t! The authors offer this potential explanation:

One plausible interpretation of these findings is that growing up under an unequal income distribution alters people’s perception of what is a fair division of resources, and thereby reduces their demand for redistribution.

(Roth and Wohlfart 2018, Page 252)

This is like thinking of slaves becoming used to the chains and eventually fond of them. I want to absorb the message of this paper more deeply, at least for my forthcoming class on economic inequality in the Spring 2019 semester, and if I have further thoughts to share on this blog, I will do so.

Fascinating new book by Posner and Weyl

Want to create a more just society? Reform private property radically and change how we vote. This is the message of a new book that came out this month.

Eric Posner and Glen Weyl recently published Radical Markets: Uprooting Capitalism and Democracy for a Just Society, Princeton University Press, 2018. You can get a taste of what’s in the book by the authors’ May 1st piece in the New York Times. The Economist called the book “arresting if eccentric manifesto for rebooting liberalism” in a mainly positive review.

The average person who has taken at least one introductory economics course might well be bewildered by the main economic idea in this book. It posits that private property of assets is a deep-seated, powerful source of monopoly power that undermines competition in economic markets. So reform private property, they argue. How? Didn’t we learn in school that without well-defined and well-enforced property rights perfect competition cannot take root?

The idea is not to abolish private property, however. It is to reform it drastically. Each person would publicly state the value of every asset they own. They would then be taxed on this. A wealth tax, you say, big deal, nothing new. What’s to prevent one from undervaluing their holdings to lessen their tax burden? The other part of this tax proposal, that’s what. Once you have declared a value for each of your assets, you must be willing to sell it for that amount to anyone willing to pay it. Technology, perhaps in the form of a smartphone app, would take care of the technicalities; something like Uber for trading houses.

The proceeds from this wealth tax can be used for public projects, perhaps funding a universal basic income, while the tax system would allow the efficient allocation of assets. So far, so Henry George in a modern guise. (And I learned from this book something really new to me: that no less a well-regarded economist than Léon Walras had ideas similar to those of Henry George on taxing land.)

But that’s not all! Posner and Weyl also want to bring into the voting system ideas from the economics of mechanism design. In fact, I only bought the book after I read a short article by Weyl with Steven Lalley on this in the American Economic Review’s Papers and Proceedings for 2018 (an ungated version is here).

Imagine every citizen being given a budget of “vote-buying money”, just as much as every other citizen. They would then be able to spend some of this “money” to buy extra votes for elections that concern issues they care a lot, at the cost of having fewer votes to cast in other elections. The prices of votes wouldn’t be linear, but quadratic. That is, one vote would cost one vote “dollar”, two votes would cost four, three would cost nine, and so on.

Incredibly at first thought, a voting system like this market-inspired one has nice properties in theory. Markets in everything, indeed!

It is natural for this proposal to raise concerns about individual rights, as the review in The Economist points out. However, a radical proposal may well be what we need in our time of political polarization and economic strain for more and more people. I will happily read this book to the end and prepare something to say about it in my economic inequality course. You will probably hear from me about it again in this very website.

Economists are too aggressive and status-obsessed

Since mid-August, I have been following with interest a discussion about the sexism in economics. The discussion burst onto the public scene with a piece by Justin Wolfers in the New York Times, in which the research by Alice Wu was featured. Many economists have contributed reasonable opinions and I have seen discussions of how economists are just mean to each other, without the meanness being specifically oriented against women (but all too often it is, with a vengeance). Today, I want to point you to this great post by Claudia Sahm. She lists some of the nasty, negative, hurtful comments she has received, in almost all cases from an economist who outranked her and was not speaking anonymously. She asks that we economists start a conversation about the evil of an anonymous website being the main source of information about the economics job market, and then to consider the problems with anonymous refereeing in the publishing process. I share this here in the spirit of amplifying her message.

Economist colleagues, our profession is impoverished by our ridiculous aggressiveness and status-obsession. What will it take to make us behave better?

What good is economics? Economic Theory?

You know to expect a subjective answer, right? OK, then. Here I go.

I am revamping the introductory graduate microeconomics course for the fall and have added to my recommended summer readings that I emailed my students the book Economic Fables by Ariel Rubinstein. This went to their inboxes a few weeks after other recommended readings that are much more technical and was intended to reinforce what I feel is my most ignored injunction to graduate students, which is to be acutely aware of the limits of economic theories they learn and use. I elaborate here on how I hope this reinforcement can happen.

Rubinstein takes an apparently extreme stance in Economic Fables. He denies that economic theory is useful. He calls economic models “fables”. In the interview that you can find in the book’s link given above, he says that a fable is a fantasy story that, if it is a good one, gives us some insight about the real world. But you cannot use a fable to predict real-world outcomes.

For an economic theorist, like Rubinstein and myself, building fantastical worlds in economic models (or fables) is valuable for the insight it offers on the structure of economic activity, and that is value enough for Rubinstein. Creating and studying economic models needs no further argument to justify its presence in Universities, or the salaries of economic theorists. Further, there is a risk that unscrupulous people may point to economic models, written in a mathematical language that is inscrutable to most, to give the discipline of economics an unwarranted aura of being a true science.

After I sent my email to the incoming graduate students, I worried that they would come to our first class in the end of August a little puzzled by this book recommendation. Why did I ask them to read Economic Fables? Doesn’t it undermine the desire to learn microeconomic theory, the subject of our class? Does it not take time away from studying the other materials I asked them to study over the summer to get readier for the class?

Before I offer my answers to these questions, let me link to a recent piece I enjoyed about the good (useful!) recent developments in economics, by Noah Smith. He points out that criticisms of economics that say it has become a religion, with its dogmatic theories, abound. Doesn’t this fit well with Rubinstein’s use of “fables” for “models”?

It fits well, but it is not an accurate criticism, and it is not productive. Lest it seem that I am lumping Rubinstein in the previous sentence, I hasten to add that I read his book as a deliberate provocation to economists and as a potentially very useful one. It is true that economic models by themselves cannot help us predict anything. They are fantasies. How then did economists find so many applications of some of their models that have clearly worked in the real world? Here is a list of such successes, from Noah Smith’s piece:

First, economists have developed some theories that really work. A good scientific theory makes testable predictions that apply to situations other than those that motivated the creation of the theory. Slowly, econ is building up a repertoire of these gems. One of them is auction theory, which predicts how buyers will bid for things like online ads or spectrum rights — Google’s profits are powered by econ theory as much as by search algorithms. Another example is matching theory, which has made it a lot easier to get an organ transplant. A third is random-utility discrete choice theory, which is used in everything from marketing to transportation planning to disaster preparedness.

Nor are econ’s successful theories limited to microeconomics. Gravity models of trade, though fairly simple in nature, have proven very successful at predicting the flow of international trade.

This list includes, of course, the one success that lets economists claim an economic theory has saved lives directly (via organ transplant chains, made possible by the work of economics Nobel prize winner Alvin Roth and colleagues such as Tayfun Sönmez). Others will surely want to add their favorite successful economic theories.

How did these successes happen? And how did the economics profession turn successfully to empirical work informed by economic fables, as Noah Smith’s article discusses so well?

Answering these questions finally brings me to answer my previous ones. Fables are fantastical stories, yes. Yet, they can be sometimes matched to the infinitely messier world we observe around us, by setting up a correspondence between fable elements and aspects of reality, to allow us to make some good predictions and improve the fables by careful empirical testing. There is a classic paper by a physicist Eugene Wigner about the “unreasonable effectiveness of mathematics in the natural sciences“. Physicists were astonished by the effectiveness of mathematical fables in explaining the natural world around us. Social scientists have a much harder problem than physicists, studying large aggregations of human beings with all their agency and foibles, but they found fables useful too.

What makes the difference? How can a fable be useful in the social sciences, such as economics? It takes the talent of a good social scientist, coupled with hard-earned experience and knowledge of empirical methods, to find correspondences between the elements of a fable and observed social reality. The fables themselves do not provide instruction how to do this.

This is why I asked my students to read Rubinstein’s Economic Fables. I am convinced that you need economic fables, written in the powerful language of mathematics, to start being useful as an applied economist — the program in which I teach is designed to orient graduate students to applied economics in several fields. My colleagues can offer instruction on how to apply the fables better than I can, but I will teach some of the basic fables. I want the students to know just what these fables are for and what the limitations of fables are. This will be more useful for their careers in the long run than just the techniques (hard enough as mastering the techniques will prove in the next few months for my students).

So, dear students, I hope you manage to hold in your mind both the idea that economic models are fables (despite the implication some draw that they are useless because they are fables) and  the idea that these fables are essential tools for any economist, but not the only essential tools. As you study, pay close attention to the assumptions in every model you encounter. (One of the best defenses of using mathematics extensively in economics is that it forces researchers to state their assumptions.) Think about how you would connect these assumptions with economic data that you can conceivably obtain. Go back and forth between fables and data. In Econometrics class, think of fables you can use to design your term paper. In Microeconomics (our class) and Macroeconomics, think about how you would subject the fables you are learning to scrutiny when you are finally finished with exams and start doing some independent research. In Mathematics for Economics, motivate yourself to persevere by remembering that you are amassing fable-building tools in a universal language that facilitates clear thinking and pushes back against intellectual dishonesty. Do these things, and your education will be professionally and personally useful and rewarding.